I have a $7,000 credit card that I need to pay off. Normally we don’t get into this bit of a scrape, I have been regularly able to pay off the balance every period, until recently. But a combination of several things, including my wife losing her job, have contributed. The interest rate is 8.99% APR and we can really only afford the minimum payments at this time. Now I have the following option, borrow $7,000 from my 401k (currently at about $100,00) and pay myself back at 9.25%. I am very nervous about taking any money out of 401k,because I realize the long-term effects of compound interest. But on the opposite side, I am paying out interest, which is of course, not ideal either.
For me, having been so responsible with the card all my life, I just hate having this sizeable credit card balance looming.
I recognize that any financial advice given is to be taken as IANAFA (Financial Advisor), but insight or links to websites would.
I don’t understand why you would borrow at a higher rate to pay off the card. 8.99% is not that bad a rate for a credit card, anyway. Is something like a home equity loan an option? Those can usually be had for 8% or less, depending on your credit.
That makes no sense whatsoever. You will be making an aggressive move that will cost you more Just pay off the credit card if that is what you want to do.
My ex did that when it turned out that he owed $40K on various credit cards. It was the only way he was ever going to be able to pay, and it worked out well.
The first couple of responses you got t your OP were from people who seemed not to understand that the interest on the 401K loan is being paid to yourself.
The interest you pay to credit card companies really adds up, so you are smart to try to get it paid off, in my opinion.
Oh, I got that – but it’s not that simple. Say you borrow $7,000 from your 401(k) at 9.25% APR. If your 401(k) investments return an APY more than the interest rate you’re paying, you end up making less money than if you had never taken the loan.
In essence, you’re just investing $7,000 worth of your 401(k) portfolio in a loan (which happens to be to you, but that’s immaterial.) The loan has a known rate of return, but the rate of return on your other 401(k) assets may be higher. You can keep the $7000 in them and just pay off your credit card the old-fashioned way – it will cost you roughly the same amount.
OTOH, maybe 9.25% is much better than your 401(k) assets are returning. In that case, it may be worth it.
The first thinmg I thought of is the opportunity cost, that is, the returns his borrowed 401k will NOT be getting. If he is in decent funds, he should be averaging better that 8%.
Borrowing from your 401k to pay creit card debt is IMHO, a BAD THING.
This is exactly it. The costs to pay off the loan will be similar under either option. However, taking the loan from the 401k carries a risk with it that you wouldn’t have if you simply continued making payments directly to the credit card company. The risk is that you quit or lose your job before the loan is repaid. If this happens, the balance of the loan will immediately become taxable income, and if you’re under age 59.5, you’ll be paying an additional 10% excise tax to boot. If this occurs, the loan from the 401k will become vastly more expensive than the other option.
No, the 401k loan is not more “expensive.” You are paying interest to yourself, in effect netting you a 9.25% annual rate in this instance. Paying the interest to the credit card company takes the money out of your pocket.
You should always pay off debts like credit cards before you try to save up money, because with credit cards you start off by losing 9-20% annually on your money because of the interest. It’s a no-brainer
Also many companies will let you keep a loan out after you leave, and some will even let you initiate a loan after you terminate employment. Rolling over a 401k is pretty easy anyway so you can take your money with you when you leave
Are you not receiving offers for lower rate (even 0%) cards? If no one’s filling your mailbox with these offers, a little googling should turn up plenty of cards at less than 8%.
I have more debt than you, all at 0%. Every year or two, when the 0% rate ends, I transfer the balance to another 0% card. They just keep sending them to me.
There are costs involved: usually there is a transfer fee of around 3%, but I’ve often gotten offers with lower or no fees. Anyway, 3% once is better than 8% over a few years.
Someone is probably going to come along to say that this technique will lower your credit rating. All I can say is that I’ve been doing it for years and my FICO score has always been in the high 700s to low 800s, and never below about 760. This is very good.
Now, I alway pay more than the minimum due, and never make late payments. This is absolutely crucial. Virtually all of these offers may revert to a higher rate (sometimes much higher) if you miss or make a payment late. (The CC companies also reserve the right to screw you this way if you make late payments to anyone else, too. Fuckers!) If that’s going to be a problem, this tactic may not be for you. Also, if you don’t have a good credit rating, you may not be able to get the lowest rates.
But I’ve been getting low-to-zero percent loans from the credit card companies for years, with no ill effects that I can see.
commasense
You may have problems if you try to get a mortgage, as it sounds like you do not keep cards open for more than a couple of years. Maybe you have a couple of cards you don’t use much that have been open for a long time. Carrying a big balance comes with its risks, and the companies are just waiting for people in your situation to miss a payment so they can jack up the rate. It’s good you keep them on their toes. Beware of Universal Default clauses in your agreement, though
If you have a home with equity, why not got for a home-equity loan ? Use it to pay off the credit card debt, interest on the loan is tax deductible and it should not affect any appreciation in house value while paying the loan off.
I suggest spending some more time doing the research when it comes to borrowing from you 401(k). Also, if you are seriously considering it, pay attention to the stock market and economic forecasts. If this economy takes a turn as many predict, borrowing from retirement savings could be a very bad idea, regardless of the reason.
Ah, it’s not just credit card companies. It’s called universal default, and while Wikipedia only talks about it with respect to credit cards, it gets worse. It is possible that if you’re late making a single payment on a car loan, a utility bill, your mortgage, or even your rent (if you don’t own a home), can trigger a universal default.
My experience in the 401k industry has been that this is the rare exception.
Rolling over an account balance is easy. Finding a employer plan that’s willing to accept assignment of a promissory note from another 401k plan is not. My experience has been that this situation is even more rare than the previous.
Why would borrowing from a 401k when the market tanks be a bad idea (assuming you maintain your job or a means of paying the loan to yourself off)? 9.25% return in a bear market is pretty impressive, no?
But you are removing the “loan” money from its investment status. If this same 401k money would have earned 10%, you are forfeiting .75%…not to mention that you have to earn the money to pay the interest back as opposed to it being investment returns. The interest payments coming from your paycheck also should have been used for your expenses or invested, but they instead are going to make your 401k whole.
for what its worth, if you or your wife has contributed to a roth IRA (or possibly roth 401k contributions), you can pull out contributions to a roth IRA penalty free, tax free anytime.
Also, if you made IRA contributions, you may be able to have those pulled back out too though I’m not exactly sure on this one.
